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Subprime lending crash will ripple housing market { February 22 2007 } Original Source Link: (May no longer be active)
http://www.businessweek.com/bwdaily/dnflash/content/feb2007/db20070221_387085.htmhttp://www.businessweek.com/bwdaily/dnflash/content/feb2007/db20070221_387085.htm
A Painful Hiss from the Subprime Balloon
February 22, 2007, 12:00AM EST
Subprime lender NovaStar's warning of little, if any, taxable income through 2011 sends another unwelcome jolt through mortgage company stocks
by Justin Bachman and Sonja Ryst
Well, at least NovaStar Financial (NFI) has $154 million in its bank accounts.
In a quarterly report that staggered analysts with the breadth of its bad news, the Kansas City (Mo.) subprime mortgage lender revealed a quarterly loss, said it may not have any taxable income through 2011, and strongly hinted its days as a real estate investment trust (REIT) are drawing to a close. Many subprime lenders avoid Uncle Sam's tax take by distributing their taxable income as dividends. If they don't have any taxable income, well, operating as a REIT may not make much sense. And as NovaStar's loan volume drops, that $154 million will serve as a needed cushion throughout a lean 2007. Chris Brendler, an analyst with Stifel Nicolaus in Baltimore, called the report "alarming" and a "shock." And as NovaStar's loan volume drops, that $154 million will serve as a needed cushion throughout a lean 2007.
The company's news was especially unwelcome to the market, coming on Feb. 21 just as the Labor Dept. reported a 0.3% jump in core inflation, above the 0.2% increase analysts had expected. That dimmed the prospects of any interest rate cut by the Federal Reserve that could buoy the housing market, and it sent stocks lower (see BusinessWeek.com, 2/21/07, "Consumer Prices Heat Up"). Minutes of the last Federal Reserve board meeting also showed that central bankers remain more worried about the threat of inflation than about an overall slowing of the housing market. "All members agreed that the predominant concern remained the risk that inflation would fail to moderate as desired," according to minutes of the Fed's Jan. 30-31 meeting released on Feb. 21.
"One of the Scariest Signs"
A subprime mortgage is one granted to borrowers with less-than-perfect credit histories because they've missed payments on credit cards, they are too young to have established a credit record, or a similar issue. As housing boomed in recent years, lenders rushed into making these loans, in some cases letting people borrow hundreds of thousands of dollars without ever having to prove their income or assets. Subprime lenders now represent about one-fifth of the overall $5.5 trillion U.S. mortgage market.
The quick growth of subprime mortgages in the recent housing boom has been eclipsed by an equally rapid decline, with several major subprime lenders, ResMae Mortgage, Mortgage Lenders Network USA, and OwnIt Mortgage Solutions declaring bankruptcy since December. Others very well may follow.
The question now: whether these troubles will spread to the broader housing market. Some argue that they will be contained, because most of these purchases were at the low end of the market. But some experts are concerned. Michael Simonsen, president and CEO of Altos Research, which studies California and 15 other major U.S. real estate markets, says subprime lenders' recent performance is "one of the scariest signs" for the larger housing market.
Ripple Effect
"The majority of the subprime business is with first-time buyers. So it may take several years to shake out," Simonsen says. "But when it comes time to sell and trade up we may find that the low end has been squeezed out." In other words, a meltdown in the subprime market could affect the supply of future buyers for years to come.
Tightening credit standards may also ripple through the broader market. Lenders across the spectrum are rewriting their loan guidelines, checking applicants' incomes and credit histories far more diligently, and generally becoming more rigorous in the face of consumer and regulatory scrutiny. That will lead to fewer loans and less access to credit. New Century Financial (NEW), for example, said its new loan business would be down 20% this year. Also this week, Wells Fargo (WFC) said it would eliminate 250 jobs in Fort Mill, S.C., as tighter lending policies it implemented last week will generate lower loan volume. Wells Fargo ranks among the country's largest subprime lenders.
As for NovaStar, the company swung to a loss of $14.4 million, or 39 cents a share, in the fourth quarter as it posted charges of about $41 million on greater delinquencies from its subprime borrowers and the need to take greater loss reserves. A year ago, the company earned $26.4 million, or 84 cents a share. Most analysts had expected the company to turn a profit.
Dismal Outlook
Yet it was the prospects for the future that shocked investors more than the dismal current results. This year, NovaStar expects to pay a dividend of about $4 a share, but Chief Executive Scott Hartman says that there will be "little or no taxable income from 2007 through 2011." Moreover, the company acknowledges that it has limited access to new funding, if it's needed. "There is a slipperier slope in finance," says Brendler, of Stifel Nicolaus. "You can lose access to capital very quickly. I'm not as optimistic as management was on their liquidity situation."
Investors savaged the stock, sending it down 42% to a new 52-week low of $10.10, roughly in line with analyst estimates of the company's book value. In May, NovaStar shares traded near $38.50, and in 2004 the stock was above $51 a share. Given the news, Brendler cut his rating on the stock to hold. Deutsche Bank (DB) analyst Stephen Laws also downgraded NovaStar to hold and slashed his target price from $29 to $8. (Deutsche Bank does business with NovaStar.)
The realization that 2007 will not likely mark a turnaround in the industry's fortunes spread to other lenders. New Century Financial, which took a 36% haircut on Feb. 8, fell another 6.5% to close at $17.55 on the NYSE, near the 52-week low it set earlier this month. Accredited Home Lenders (LEND) fell 3.3%, to $24.60 on the Nasdaq. Shares of prime mortgage lenders also slipped. Countrywide Financial (CFC) shares dropped 2.2%, to $40.69; Impac Mortgage Holdings (IMH) fell 4%, to $7.86; IndyMac Bancorp (NDE) dipped 2.3%, to $36.32; and H&R Block (HRB) was down 2.9%, to $22.30.
On a pool of mortgages NovaStar securitized in September, 2006, more than 3% are more than 30 days past due, Morningstar (MORN) reported Feb. 9. "If delinquencies in NovaStar's mortgages continue to rise, pullback from investors in its securities could create a liquidity crunch, limiting NovaStar's ability to originate new loans in the future," analyst Ryan Lentell wrote Feb. 9. After the latest NovaStar news, Lentell added that "liquidity remains our No. 1 concern associated with the firm."
"More to Come"
Through a spokesman, NovaStar officials declined interview requests. In a Feb. 20 conference call with analysts, company co-founder Hartman stressed his company's new, tighter lending guidelines and predicted future failures in the industry given the "pretty big number" that have already shut down.
"I believe that [by] the second half of '07, I think brokers will have adapted to some of the new guidelines. So I think they will do a better job of marketing to borrowers that meet those guidelines. I think that is a change we need to see take place," he said. "And I think there will continue to be people who go out of business. I think there is more to come."
Bachman is deputy news director for BusinessWeek.com, and Ryst is a reporter for BusinessWeek.com in New York.
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